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Exam 3 reviewChapt 11:•The classical model was the first attempt to explain –Determinants of the price level–National levels of real GDP–Employment–Consumption–Saving–Investment•Classical economistsassumed wages and prices were flexible, and that competitive markets existed throughout the economy.•Say’s Law–A dictum of economist J.B. Say that supply creates its own demand–Producing goods and services generates the means and the willingness to purchase other goods and services.–Supply creates its own demand; hence it follows that desired expenditures will equal actual expenditures.•Assumptions of the classical model–Pure competition exists.–Wages and prices are flexible.–People are motivated by self-interest.–People cannot be fooled by money illusion.•Money Illusion–Reacting to changes in money prices rather than relative prices–If a worker whose wages double when the price level also doubles thinks he or she is better off, that worker is suffering from money illusion.•Consequences of The Assumptions–If the role of government in the economy is minimal,–If pure competition prevails, and all prices and wages are flexible,–If people are self-interested, and do not experience money illusion,–Then problems in the macroeconomy will be temporary and the market will correct itself.•Equilibrium in the credit market–When income is saved, it is not reflected in product demand.–It is a type of leakage from the circular flow of income and output, because saving withdraws funds from the income stream.–Therefore, total planned F can fall short of total current real GDP. –Classical economists contended each dollar saved would be matched by business investment. –Leakages would thus equal injections.–At equilibrium, the price of credit—the interest rate—ensures that the amount of credit demanded equals the amount supplied.•Equating Desired Saving and Investment in the Classical Model–Changes in saving and investment create a surplus or shortage in the short run.–In the long run, this is offset by changes in the interest rate.–This interest rate adjustment returns the market to equilibrium where S = I.•Question–Would unemployment be a problem in the classical model?